Irrespective of the type of loan, knowledge concerning interest calculation is beneficial. It will allow a prospective borrower to stay a step ahead while opting for a personal loan. The compound and simple interest have clear-cut differences both in the case of investments and borrowing.
In the case of investments, simple interest will yield a lower amount than compound interest, whereas, for borrowing, an interest calculated on simple interest will be significantly lower than compound interest. For the ease of an applicant’s calculations, the compound interest and simple interest formula are given below –
Compound Interest (C.I.):
C.I. = P [(1 + r)n – 1]
Here, P = Principal; r = rate of interest; n = tenor.
Simple Interest (S.I.):
S.I. = P * I * N
Here, P = Principal; I = Yearly interest rate; N = Time or Tenor.
How to calculate compound interest?
The calculation of compound interest is a simple process. A prospective borrower needs to put the respective values in their proper places.
For example, if the principal is Rs.1.5 lakh in the first year with interest payable Rs.18,000, then after 1 year, the closing balance will be Rs.1,68,000, and subsequently, the interest outgo will be Rs.20,160 for the second year and Rs.22,579 for the third year. At the end of the third year, the total compound interest will be Rs.60,739, and the closing balance will be Rs.2,10,739.
How to calculate simple interest?
The mathematical formula of simple interest is rather simple than compound interest. This can be calculated in a similar way but with a different formula.
For example, for a principal of Rs.1.5 lakh, with a tenor of 3 years and rate of interest of 12%, the simple interest will be –
S.I. = Rs. (1,50,000 * 0.12 * 3) = Rs.54,000.
As calculating compound interest is fairly complicated manually, it is advised to opt for an interest calculator. Or, using M.S. Excel to calculate interest makes the calculations fairly simple.
M.S. Excel can also be used to calculate the EMI for personal loans. The formula to calculate EMI is PMT(RATE, NPER, P.V., F.V., TYPE).
Here, RATE = rate of interest; NPER = loan tenor or count of total monthly interest; PV = principal amount or present value; FV = future value; TYPE = 0 or 1 depending on payment due.
So, before availing of a personal loan, knowing about types of interest rates and calculating those beforehand with keep a borrower updated. Besides, intending borrowers should also know how are personal loan applications processed.
Apart from calculating the interest rates, it is also important to know how to calculate personal loan EMIs and the total interest amount beforehand, as these will improve the financial understanding. Most financial experts also advise using a personal loan EMI calculator due to its accuracy and accelerated calculations.
Steps to use EMI calculator
Step 1: Enter desired loan amount.
Step 2: Put in the tenor.
Step 3: Enter the interest rate.
Step 4: Finally, if an applicant clicks on ‘Calculate’, the calculator will display the values of total interest payable and the total payment amount.
While applying, if the total interest amount and the EMI are on the higher side, a prospective borrower can check a few pointers to reduce those. Also, it is advised to know certain factors affecting personal loan interest rates.
Points to reduce the interest payable
- Adopting financial practices to improve the CIBIL score.
- Clearing existing debts faster.
- Availing part-prepayment facility.
- Opting for a shorter tenor.
In India, selected financial institutions like Bajaj Finserv offer pre-approved offers to expedite the loan application process. These offers are available on selected financial products like personal loans, business loans, etc. To check pre-approved loan offers, applicants have to enter their personal details.
So, before applying, calculating interests using compound interest and simple interest formulas can simplify the loan application process.
